What if you didn’t have any debt, how much money would you save? I alone would save around $600 dollars a month if I paid off all of my debt, including my car, some student loans, and my credit card. The trick is to actually pay off this debt, which is so much easier said than done, but once this is complete you can start investing those liberated dollars and grow your wealth like crazy.
Methods of Debt Reduction
This is one of the more popular strategies to reducing your debt, made popular by financial radio guy and author Dave Ramsey. Basically, attack the debt with the lowest balance first and pay only the minimum on every other debt. Do not try to take down the one with the highest interest rate (unless it also happens to have the smallest balance). The money freed up from paying on that small debt can be applied to the next biggest item of debt, and so on. Ramsey’s thinking is more psychological than anything, reasoning that when people see that they’ve actually accomplished paying off one item of debt completely, they build up momentum in paying off the other items. However, as you may have already grasped, while you’re paying off those small loans, the one with the highest interest rate is still costing you a lot more money in interest payments.
Use if you get discouraged easily and tend to need constant proof of accomplishment.
Avalanche Method This method states that one should pay off their debt in order of interest rates, from highest to lowest, since high interest rates cause you to spend much more money on interest payments. Critics of this method say that it’s difficult for people to stick to this plan as it’s more difficult to see progress and can feel overwhelming, but of all of the debt reduction strategies out there, this one will have you paying the least amount in interest.
Use this if you’re dedicated, don’t need constant reassurance, and can stick with things long term.
Scarcity Method There is one other method that I want to present, and as far as I know it’s not espoused by any personal finance superstar out there, mainly because I’ve accidentally created it. Instead of trying to save money, whenever I get a paycheck, I calculate how much I need to keep out of it to pay bills, and then everything else left over goes to one of my debts. That way I can’t spend money on things I don’t need, because I only have enough money for the things I need. Yeah, it’s kinda scary, since at times I’ve only had about a $150-$200 dollar buffer for any kind of unexpected expenses, but in an odd way it’s kind of liberating as well, I mean after all, If you don’t have money you don’t have to worry about saving or spending it.
You should probably just not ever use this method
Eliminating debt using any method is always a good thing, and often times the best way to do anything at all is to just start doing it, plain and simple. There are better methods than others, but all of the methods are better than not reducing your debt at all. Motivation for eliminating debt:
- You’ll have more money monthly. What could you do with an extra $100 a month? $200 a month? $600?
- The peace of mind found only through knowing that you owe nothing to anyone, and that creditors hold no sway over you.
- Being one of the few in America with little to no debt
- Get approved for larger loans with lower interest rates (not that I’m proposing to eliminate debt to go right back into debt!)
- Setting an example for your children, that if you don’t have the cash for something (other than a house or perhaps a car), then you don’t buy it.
- Having a small amount of debt allows you to save and invest more money, which will bring you closer to financial independence.
Of course, once you actually do get all that debt eliminated, you'll need to know what to do with all that extra dough. Luckily, I'll be adding posts on investing all that extra cash in the coming months, but for now check out this Practical Investing Guide for Beginners.